Client Bulletin: Northern Ireland Discount Rate Update 12th June 2020
Following on from our client bulletin of 27th February 2020, where now for Northern Ireland Discount Rate?
The statutory consultation announced by the Minister of Justice is likely to conclude shortly. The burning issue is whether the Minister will proceed to formally announce a -1.75% rate (for which secondary legislation will be required) or decide that in the current dire economic circumstances, it would be inappropriate to do so.
The Wells v Wells methodology as previously interpreted by the then Lord Chancellor Liz Truss (2017) has been acknowledged to be unsuitable and not fit for purpose. It is welcome news that the Minister has made it clear that she will also shortly commence a public consultation around necessary changes to the current methodology for working out the rate (which it has been assumed would require primary legislation).
There is however an alternative:
The Minister’s Power under the 1996 Damages Act is arguably unfettered
Section 1 (1) of the Damages Act 1996 empowers the Lord Chancellor (and in the case of Northern Ireland the Minister of Justice) to prescribe the discount rate which the Court shall take into account when determining the return to be expected from the investment of the sum awarded as future loss damages in an action for personal injuries.
The power of the Minister of Justice in Northern Ireland to set the appropriate discount rate is unfettered. In the Wells -v- Wells decision, it was suggested that “only a marked change of economic circumstances “should entitle any party to reopen the debate” in advance of the Lord Chancellor’s decision. It could be argued that the Lords were clearly not intending to tie the Minister’s hands as to how the rate was to be set under the Damages Act 1996.
The Act makes no reference to ILGS as the measure.
In passing the 1996 Act, Parliament clearly took upon itself, how the discount rate would be set. The detailed working out was left to the Lord Chancellor; or in the case of Northern Ireland to the Minister.
When the House of Lords handed down its decision in 1999, the statutory power under the Damages Act 1996 had not been exercised and the Lords’ decision was clearly expressed within the judgement to be ‘in the meantime’ pending that exercise of statutory power.
Significance of Wells -v- Wells
The statutory power was exercised in 2001, and 2017 (in relation to England and Wales only), when the rates were set initially at 2.5% and more recently -0.75%. On each occasion the decisions were expressed to be based upon or guided by the principles set out in Wells -v- Wells. Liz Truss claimed this was the only rate she could set as in her view she was bound by the decision in Wells -v- Wells.
What principles flow from Wells -v- Wells?
The leading judgement of Lord Hope set out that:-
‘The measure of the discount is the rate of return that can be reasonably expected on that sum [the lump sum for future loss] if invested in such way to enable the Plaintiff to meet the whole amount of the loss during the entire period which has been assumed for it, by the expenditure of income with capital’; and
‘…[The rate]… is the rate of interest to be expected where the investment is without risk, there being no question about the availability of money where the investor requires repayment of the capital and there being no question of loss due to inflation.’
Is the Minister constrained by Wells -v- Wells?. It is clear that other factors have been considered previously. The Explanatory Notes which accompanied the September 2017 Consultation Command paper, of the then Lord Chancellor, David Lidington, described the methodology to be applied in setting the rate under Section 1 of the Damages Act 1996. It ‘… is not specified within the Act itself but that this is largely governed by principles set down in case law by the Courts (in particular in the decision by the House of Lords in Wells -v- Wells)…’
During a decade of consultation papers since the initial launch of the discount rate consultation at the end of 2010, there have been at times subtle changes in the way in which the accepted level of risk has been described as ‘risk free’, ‘very low risk’ and ‘low risk’.
Any analysis of the discount rate changes (2001 and 2017) show that issues other than those specifically flagged in Wells -v- Wells were considered. In the Privy Council decision of Helmot -v- Simon 2011 (dealing with the discount rate in Guernsey), Lord Hope acknowledged that when the rate was set by Lord Irvine he took into account matters which played no part in the analysis of Wells. In the Statement of Reasons, Lord Irvine expressly noted that real claimants with a large compensation award, properly advised as to the investment objectives that their lump sum needed to fulfil, would not be advised to invest solely, or even in the main, in ILGS. They would be advised to invest in a mixed portfolio where risk was managed to be very low.
It seems reasonably clear that in announcing the proposal, the Minister will have received advice from a range of experts, including the Government Actuary. The Minister seems prepared to consider alternatives to the methods used in England/Wales by previous Chancellors (Lord Irvine in 2001 and Liz Truss in 2017), e.g. the averaging period for ILGS has changed from three years to one year and stock with less than 20 years (rather than 5 years) to maturity have been excluded.
In making these choices, the Minister is considering the criteria to be applied in using the existing methodology. The Minister is exercising her discretion. At times this may seem to favour the plaintiff and at times favour the defendant. Nonetheless it is clear that by making these choices in the exercise of her statutory power, the Minister is considering a different approach, than that used in Wells -v- Wells, e.g. where the majority opted for a 3 year average of gross yields on ILGs. If the Minister’s exercise of her statutory power allows her to do this, then similarly the Minister can consider what other changes she might consider necessary now in 2020 to best reflect the principle of 100% compensation which is the fundamental common law principle underpinning Wells -v- Wells. In 1999, the House of Lords took the view that ILGs were the best method to guard against inflation. Indexed linked Government stock is not however the risk free vehicle pictured by the House of Lords. There are better alternatives available in 2020. The Minister is not constrained by having only to consider investment in 100% ILGS.
Is a discount rate based on 100% ILGS fit for purpose?
The current methodology based around a hypothetical risk averse portfolio based on 100% ILGS requires recalibration and change. The fundamental concept underlying full compensation is that the lump sum to meet future needs should be sufficient to meet all of those expected losses in full as and when they are expected to fall.
The principle of 100% compensation is a well-established feature of the common law approach to the assessment of damages. In reality, a lump sum award will nearly always either over or under compensate a Plaintiff. Many factors come into play which will have a bearing on an individual Plaintiff outcome. If he/she lives longer or less than statistically expected, the funds will either over/under-compensate.
Let us assume that the discount rate should continue to be based on a hypothetical investment strategy of an unsophisticated risk-averse Plaintiff. What level of risk should then be acceptable and still remain consistent with the 100% compensation principle? The risks are two-fold:-
Firstly that the capital will be available as and when needed; and
Secondly the risks caused by inflation.
What really matters is which hypothetical investment strategy in principle delivers the best Plaintiff outcomes that would satisfy the 100% compensation principle (when properly understood) and then, which discount rate is implied by that strategy. The guiding principle in Wells -v- Wells was to ensure that the injured Plaintiff received 100% compensation, as far as was possible.
Whilst in 1999 the Lords may have thought that investment in 100% ILGS would be a risk free strategy, it is clear that is not now the case, if it ever was. In GAD’s Analysis carried out for the MoJ (July 2017 page 6), the Government Actuary acknowledged that the notion of ‘… the risk free portfolio…’ is only a theoretical construct and that even a portfolio made up of 100% ILGS would not produce risk free Plaintiff outcomes.
HM Treasury noted that in the current climate ILGS could not now be said to offer a risk free return. The price of ILGS has over the last number of years been driven to unprecedented levels, that ordinary investors have to pay a very high price for inflation protection. As GAD noted in its response to the MoJ consultation (January 2017) ‘it is unlikely that such a position was envisaged at the time (Wells -v- Wells)’. HM Treasury also noted that no individual investment instrument could be seen to be ‘risk free’.
Whether ILGS were ever the ‘without risk’ investment option envisaged in Wells -v- Wells, is highly questionable. HM Treasury in its Response (12th January 2017) to the MoJ’s consultation ‘The Damages Act 1996; The Discount Rate’ was strongly of the view that economic and financial developments in the UK since the setting of the rate in 2001, required a reconsideration of the range and balance of instruments used to calculate the discount rate and which continued to meet the principles established in Wells -v- Wells in changed circumstances. HM Treasury highlighted three specific changes around the ILGS market:-
The significant decline in real yields on ILGS (particularly since the financial crisis of 2008). Yields had gone from being universally positive to negative on nearly every maturity point.
Markets risks. Since the global financial crisis, price volatility in ILGS is now higher particularly in ILGS with longer maturities.
A new range of investments have now come onto the market (since Wells -v- Wells was decided), which offer inflation-based returns.
HM Treasury concluded in 2017 that ILGS could not be said to present a risk-free return to a risk averse investor. HM Treasury’s recommendation was that a discount rate ‘…which approximate the Wells -v- Wells principles in today’s circumstances…’ needs to look toward a more diversified/mixed portfolio (and therefore away from 100% investment in ILGS).
The report of the Expert Panel appointed by the Government in October 2015 also reached the same conclusion following an extensive financial analysis. The Expert Panel noted in appendix 2 that ‘100% ILGS investment lies very far from the efficient frontier of achieving the best return for a given degree of risk, as it offers much poor returns and significantly higher volatility than ‘best-risk’ portfolio, bonds and equities’.
An alternative approach under the current methodology
The goal is to find a solution which still meets the 100% compensation rule. The choice over which hypothetical investment portfolio, is a selection choice for the Minister to make.
Wells -v- Wells does not tie the Minister’s hands or restrict other notional investment choices. The House of Lords choice of ILGS as the appropriate benchmark (in 1999) was contingent and based on the ability of ILGS satisfying the concept of 100% compensation. If ILGS were ever the correct investment choice, the clear evidence and analyses over the last 10 years in government papers and consultations has shown that this is no longer the case. There is no a priori to prefer ILGS if there are other investment strategies that can equally or better satisfy the need for 100% compensation.
The key test is whether ILGS (or any other alternative investment instrument) meet this test. This will depend on the prevailing circumstances at the time, a point acknowledged by the then Lord Chancellor, Liz Truss, when carrying out a similar exercise to that now being undertaken by the Minister. In her Statement of Reasons (27th February 2017, paragraph 9), Liz Truss emphasised that her choice was very much made ‘in the current markets’ and ‘at the current time’. Her aim was to select a hypothetical portfolio which offered least risk to investors (not no risk) in protecting the award of damages again inflation and market risk. At that time, her decision was to continue using a 100% ILGS formula. A decision much criticised at the time and since. It is clear that the advice and recommendations from HM Treasury at the time, was in fact to move away from that model and towards a mixed/variable portfolio.
Ultimately, the Minister will have to consider how best to achieve the principle of 100% compensation in lump sum awards. In setting this goal, it is important to understand that notwithstanding this principle, individual lump sum awards will almost invariably lead to either under or over-compensation. The application of the discount rate (at whatever rate) is very much an adjustment exercise and that is never an exact science. The Lord Chancellor, Lord Irvine, acknowledged in 2001 that the approach to ‘setting the personal injury discount rate must be fairly broad brush’. Whether the hypothetical portfolio chosen by the Minister is stated to be ‘very low risk’, ‘low risk’ or ‘risk free’ is, we argue an unnecessary distraction. Provided the portfolio selected fulfils the objectives around the principle of 100% compensation, as far as reasonably practical, then this should be the prime objective. The debate around the setting of the discount rate has since Wells v Wells focused on an impossible goal – the notion of adopting an entirely risk free approach. A plaintiffs’ costs and needs can never be predicted with certainty. Market price of any investment (including ILGS) can vary.
The goal is to best deliver how an unsophisticated risk adverse plaintiff can meet his/her costs in full, as they arise. An alternative mixed portfolio approach which meets this objective (rather than 100% ILGS) provides a workable alternative to the current methodology which was outlined in the Minister’s announcement of 27th February 2020 (which was based on yields from ILGS using a 1 year average). It is clear that ILGS is no longer a suitable choice.
Future public consultation/methodology changes?
The launch of the statutory consultation on 27th February 2020 by the Minister also in passing references future changes to the current methodology. Firstly it is arguable that the Minister can effect changes to the current methodology (or at least to the criteria used) without having to rely on primary legislative changes. The Minister is under a continuing legal duty to ensure that the rate prescribed is not inappropriate. It is extremely difficult to see in what circumstances it could be argued that the Minister is acting appropriately if the proposed rate change proceeds using a hypothetical investment portfolio of 100% ILGS. The conclusion of consultations over the last decade, around the discount rate, all indicate that ILGS is no longer a suitable choice.
Looking forward to the Minister’s likely announcement next week on the conclusion of the statutory consultation and commencement of a public consultation around legislative changes to the discount rate methodology, it is to be hoped that further consideration may have been given to the proposed -1.75% rate. If such an announcement is made, the public consultation around changes will no doubt be fast tracked. In practical terms as the rate change will require secondary legislation, it seems unlikely there will be sufficient Assembly time available before the Summer recess. It is to be hoped that serious consideration be given to prioritising the need for a changed methodology in Northern Ireland, whether that be by remoulding the current methodology (using a mixed portfolio approach) or by suspending or terminating the current statutory consultation and moving directly to public consultation and statutory reform. To do otherwise would lead to a minus discount rate in this jurisdiction which is completely out of step with the other UK jurisdictions and which is based on a flawed and out of date concept.
12th June 2020